Yesterday, Coventry reported that its Medicare private fee-for-service business will miss its second quarter medical cost ratio projections by more than 300 basis points and that it will miss its prior second quarter estimates for its commercial medial cost ratio by a whopping 200 basis points.
Today, Aetna and Humana reaffirmed their prior earnings guidance leading people to conclude the sheer size of the Coventry earnings problem is largely internal.
What really troubles me about the Coventry announcement is that:
- Their private fee-for-service (PFFS) problem should have been obvious to to their actuaries since Coventry had apparently not issued ID cards to new PFFS customers and claims weren't coming in as they should have been. The PFFS data had to be too good to be true and that should have been obvious.
- Their explanation for seeing their commercial trend jump by 200 bps is inadequate. They said they are seeing an increase in large claims and hospital claims generally. That is true of other health plans but not to anywhere near the same degree as Coventry. It is not clear to me that Coventry has really gotten to the bottom of all of this.
We've said for the last three years that the core operating growth rate in a purely commercial business was not as high as some were suggesting. We took some flak for that. But more recently, the reality of that seems to have become more evident. But that is away different from an underwriting cycle. Underwriting cycles are also not caused by variations in medical cost trends. Variations in medical cost trends generally do not happen quickly and given the progress in analytics within the industry, will be pretty closely anticipated in pricing. That doesn't suggest we will never make a mistake and miss it a little, but that's far from an underwriting cycle.
Underwriting cycles are caused solely by lack of pricing discipline, either consciously, which I actually think is less common, or unconsciously, through lack of financial control. This isn't a new topic either. We've been, for many years, answering the question of whether there's an underwriting cycle. We've cited a consolidation in the industry, growth of for-profit blues, improved analytics and so on and on and on. Those reasons are as valid and real today as they have been for the last five years. It makes no economic sense to chase market share at the expense of pricing discipline.
I'm reasonably confident that that's understood across the industry, but I'm absolutely certain that it's understood at Coventry. So don't look for the operating margins of our commercial operations to fall off the table. They won't. If we have to shrink a little, which we don't think we will do, but we will, we will not sacrifice margin at the expense of market share, and that is the only thing that causes an underwriting cycle.
From the CFO on the same call:
At the risk of sounding like a broken record, I want to reiterate our views on commercial trend in pricing as well. We continue to see no evidence of an overall acceleration of cost trend in 2008 versus 2007. Our outlook remains that trend will be stable in 2008 versus 2007, in the neighborhood of 7.5%. Over a long period of time, we have exhibited an attention to detail and an unwavering discipline in the pricing arena, and to no surprise, this will not be changing. We remain firmly committed to having our commercial price increases at least equal to medical cost trends. The competitive environment is, as always, a very competitive arena. Growth is not easy to come by, but despite isolated local market skirmishes, it is still a rational environment where those that have a low-cost structure, those that are disciplined, those that are close to the details and fundamentals of the business, will succeed over the long haul.Less than two months later Coventry is reporting 9% commercial trend.
I guess the moral of the story is that you never want to get cocky in this business.